UNIT III

CASH FLOW

TYPES OF CASH FLOW DIAGRAM

COST DOMINATED CASH FLOW DIAGRAM

REVENUE DOMINATED CASH FLOW DIAGRAM

COST DOMINATED CASH FLOW

DIAGRAM
Out flow cash is assigned with positive sign.
The profit, revenue, salvage value is assigned
with negative sign.

REVENUE DOMINATED CASH

FLOW
DIAGRAM
Out flow cash is assigned with Negative sign.
The Profit, Revenue, Salvage Value is assigned
with Positive sign.

REVENUE DOMINATED CASH FLOW

DIAGRAM (PRESENT WORTH
METHOD)
S

R
1
0

R
2
1

R
3

R
j

R
n

P
Here P initial investment.
Rj net revenue at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
PW(i) = -P + R1{1/(1+i)1) + R2{1/(1+i)2)+. + Rj {1/(1+i)j } +
n

COST DOMINATED CASH FLOW

DIAGRAM (PRESENT WORTH
METHOD)
S
0

j
n

C1

C2

C
3

Cj

C
n

P
Here P initial investment.
Cj net cost of operation and maintenance at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
PW(i) = P + C1{1/(1+i)1) + C2{1/(1+i)2)+. + Cj {1/(1+i)j } +
Cn{1/(1+i)n } - S{1/(1+i)n }

DECISION PARAMETER
Alternative with minimum cost, then the
alternative with the least present worth is
selected.
Alternative with maximum profit, then the
alternative with the maximum present worth
is selected.

Alpha industry is planning to expand its production operation.

It has identified three different technologies for meeting the goal.
The initial outlay and annual revenues with respect to each of the technologies are
summarized in Table 4.1
suggest the best technology which is to be implemented based on the present worth
method of comparison assuming 20% interest rate, compounded annually.
ALTERNATIVE

Initial
outlay

Annual revenue
(Rs.)

Life
(years)

Technology 1

(Rs.)
12,00,000

4,00,000

10

Technology 2

20,00,000

6,00,000

10

Technology 3

18,00,000

5,00,000

10

Technology I
Initial outlay, P = Rs.12,00,000.
Annual Revenue, A = Rs. 4,00,000.
Interest Rate, i = 20 %
Life of this technology, n = 10 years.

4,00,00
0
0
12,00,0
00

4,00,0004,00,000

R
j

PW(i%)
= - P + A * (P/A, i%, n )
PW(20%) = -1200000 + 4,00,000 (P/A,20%,10)
= -1200000 + 4,00,000 * (4.195)
= Rs.4,77,000.

4,00,000

Technology II
Initial outlay, P = Rs.20,00,000.
Annual Revenue, A = Rs. 6,00,000.
Interest Rate, i = 20 %
Life of this technology, n = 10 years.

6,00,00
0
0
20,00,0
00

6,00,0006,00,000

R
j

PW(i%)
= - P + A * (P/A, i%, n )
PW(20%) = -20,00,000 + 6,00,000 (P/A,20%,10)
= -20,00,000 + 6,00,000 * (4.195)
= Rs.5,15,500.

6,00,000

Technology III
Initial outlay, P = Rs.18,00,000.
Annual Revenue, A = Rs. 5,00,000.
Interest Rate, i = 20 %
Life of this technology, n = 10 years.

5,00,00
0
0
18,00,0
00

5,00,0005,00,000

R
j

PW(i%)
= - P + A * (P/A, i%, n )
PW(20%) = - 18,00,000 + 5,00,000 (P/A,20%,10)
= - 18,00,000 + 5,00,000 * (4.195)
= Rs.2,96,250.

5,00,000

Result :
From the above calculations, it is clear that the
present worth of technology 2 is the highest among
all the technologies.
Therefore, technology 2 is suggested
implementation to expand the production.

for

An engineer has two bids for an elevator to be installed in a new building.

The details of the bids for the elevators are as follows:
bid
Initial cost
(Rs.)

Engineers s estimates
Service
Annual operations&
Life(years)
Maintenance cost
(Rs).

Alpha Elevator Inc.

4,50,000

15

27,000

Beta Elevator Inc.

5,40,000

15

28,500

BiD 1: Alpha Elevator Inc.

Initial Cost, P = Rs. 4,50,000
Annual operation and maintenance cost , A
= Rs 27,000
Life , n = 15 years
Interest rate , i = 15%

3
15

27,00
27,00 27,000
0
0
450000
PW(i%) = P + A * (P/A , i%, n )
= 4,50,000 + 27,000 * (P/A, 15%, 15)
= 4,50,000 + 27,000 * 5.8474
= Rs.6,07,879.80

27000

BiD 2: Beta Elevator Inc.

Initial Cost, P = Rs. 5,40,000
Annual operation and maintenance cost , A
= Rs 28,500
Life , n = 15 years
Interest rate , i = 15%

3
15

28,50
28,50 28,500
0
5,40,000 0
PW(i%) = P + A * (P/A , i%, n )
= 5,40,000 + 28,500 * (P/A, 15%, 15)
= 5,40,000 + 28,500 * 5.8474
= Rs.7,60,650.90

28,50
0

Result :
The Total present worth cost of bid 1 is
less than that of bid 2.
Hence bid 1 is selected for the
implementation.

REVENUE DOMINATED CASH FLOW

DIAGRAM (FUTURE WORTH
METHOD)
S

R
1
0

R
2
1

R
3
3

R
j

R
n

P
Here P initial investment.
Rj net revenue at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
FW(i) = -P (1+i)n + R1(1+i)n-1 + R2(1+i)n-2+. + Rj (1+i)n-j + Rn + S

COST DOMINATED CASH FLOW

DIAGRAM (FUTURE WORTH
METHOD)
S
0

j
n

C1

C2

C
3

Cj

C
n

P
Here P initial investment.
Cj net cost of operation and maintenance at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
PW(i) = P (1+i)n + C1 (1+i)n-1 + C2 (1+i)n-2 +. + Cj (1+i)n-j +. +
Cn - S

DECISION PARAMETER
Alternatives with the maximum future worth
of NET REVENUE is selected.
Alternative with the minimum future worth
of NET COST is selected.

Consider the following two mutually exclusive alternatives:

At I = 18%,
Select the best alternative based on future worth method of comparison.
End of year
Alternative

A (Rs.)

-50,00,000 20,00,000 20,00,000 20,00,000 20,00,000

B (Rs.)

-45,00,000 18,00,000 18,00,000 18,00,000 18,00,000

ALTERNATIVE I
Initial investment, P = Rs. 50,00,000
Annual equivalent investment, A = Rs. 20,00,000
Interest rate, i = 18%
Life of the alternative n = 4 years

20,00,000 20,00,00020,00,000

5000000
FW (i%) = -P (F/P,i%,n) + A (F/A,i%,n)
= -50,00,000 (F/P,18%,4) + 20,00,000 (F/A,18%,4)
= -50,00,000 (1.939) + 20,00,000 (5.215)
= Rs.7,35,000.

20,00,00
0
4

ALTERNATIVE II
Initial investment, P = Rs. 45,00,000
Annual equivalent investment, A = Rs. 18,00,000
Interest rate, i = 18%
Life of the alternative n = 4 years

18,00,000 18,00,00018,00,000

45,00,000
FW (i%) = -P (F/P,i%,n) + A (F/A,i%,n)
= -45,00,000 (F/P,18%,4) + 18,00,000 (F/A,18%,4)
= -45,00,000 (1.939) + 18,00,000 (5.215)
= Rs.6,61,500.

18,00,00
0
4

RESULT :
The future worth of alternative A is greater than
B ,hence A is to be selected.

M/S Krishna castings Ltd. is planning to replace its annealing furnace.

It has received tenders from three different original manufacturers of annealing furnace.
The details are as follows.
Which is the best alternative based on future worth method at i = 20%?

Initial cost (Rs.)

Life (years)
Annual operation
and maintenance cost
(Rs.)
Salvage value after
12 years

1
80,00,000
12
8,00,000

Manufacturer
2
70,00,000
12
9,00,000

3
90,00,000
12
8,50,000

5,00,000

4,00,000

7,00,000

Alternative I
First cost , P= Rs. 80,00,000
Life, n = 12 years
Annual operations and maintenance cost, A = Rs. 8,00,000
Salvage value at the end of furnace life S = Rs. 5,00,000

5,00,000
0

8,00,000 8,00,000 8,00,000

.
.

80,00,000
FW (i%) = P (F/P,i%,n) + A (F/A,i%,n) S
= 80,00,000 ((F/P,20%,12) + 8,00,000 (F/A,20%,12) 5,00,000
= 80,00,000 (8.916) + 8,00,000 (39.581) 5,00,000
= Rs. 10,24,92,800.

1
2
8,00,000

Alternative II
First cost , P= Rs. 70,00,000
Life, n = 12 years
Annual operations and maintenance cost, A = Rs. 9,00,000
Salvage value at the end of furnace life S = Rs. 4,00,000

4,00,000
0

9,00,000 9,00,000 9,00,000

.
.

70,00,000
FW (i%) = P (F/P,i%,n) + A (F/A,i%,n) S
= 70,00,000 ((F/P,20%,12) + 9,00,000 (F/A,20%,12) 4,00,000
= 70,00,000 (8.916) + 9,00,000 (39.581) 4,00,000
= Rs. 9,76,34,900.

1
2
9,00,000

Alternative III
First cost , P= Rs. 90,00,000
Life, n = 12 years
Annual operations and maintenance cost, A = Rs. 8,50,000
Salvage value at the end of furnace life S = Rs. 7,00,000

7,00,000
0

8,50,000 8,50,000 8,50,000

.
.

90,00,000
FW (i%) = P (F/P,i%,n) + A (F/A,i%,n) S
= 90,00,000 ((F/P,20%,12) + 8,50,000 (F/A,20%,12) 7,00,000
= 90,00,000 (8.916) + 8,50,000 (39.581) 7,00,000
= Rs. 11,31,87,850.

1
2
8,50,000

RESULT:
The future worth cost of alternative 2 is less than
that of the other two alternative. Hence they go
for selecting the second alternatives

REVENUE DOMINATED CASH FLOW

DIAGRAM (ANNUAL EQUIVALENT
METHOD)
S
R
1
0

R
2
1

R
3
3

R
j

R
n

P
Here P initial investment.
Rj net revenue at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
FW(i) = -P (1+i)n + R1(1+i)1 + R2(1+i)2+. + Rj (1+i)j + Rn(1+i)n +
jn

COST DOMINATED CASH FLOW

DIAGRAM (FUTURE WORTH
METHOD)
S
0

j
n

C1

C2

C
3

Cj

C
n

P
Here P initial investment.
Cj net cost of operation and maintenance at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
PW(i) = P (1+i)n + C1 (1+i)n-1 + C2 (1+i)n-2 +. + Cj (1+i)n-j +. +
Cn - S

DECISION PARAMETER
Alternatives with the maximum future worth
of NET REVENUE is selected.
Alternative with the minimum future worth
of NET COST is selected.

A company is planning to purchase an advanced machine centre.

Three original manufacturers have responded to its tender whose particulars are
tabulated as follow
Manufacturer

Down payment
(Rs.)

Yearly equal
installment
(Rs.)

No. of
Installment
s.

5,00,000

2,00,000

15

4,00,000

3,00,000

15

6,00,000

1,50,000

15

Determine the best alternative based on the annual equivalent method by

assuming i = 20%, compounded annually.

ALTERNATIVE I
Down payment, P = Rs.5,00,000
Yearly equal installment, A = Rs.2,00,000
n = 15 years
i= 20%

.
15

2,00,000 2,00,0002,00,000
5,00,000
AE (i%) = P(A/P,i%,n) + A
= 5,00,000 (A/P,20%,15) + 2,00,000
= 5,00,000 (0.2139) + 2,00,000
= Rs. 3,06,950.

2,00,000

ALTERNATIVE II
Down payment, P = Rs.4,00,000
Yearly equal installment, A = Rs.3,00,000
n = 15 years
i= 20%

.
15

3,00,000 3,00,0003,00,000
4,00,000
AE (i%) = P(A/P,i%,n) + A
= 4,00,000 (A/P,20%,15) + 3,00,000
= 4,00,000 (0.2139) + 3,00,000
= Rs. 3,85,560.

3,00,000

ALTERNATIVE II
Down payment, P = Rs.6,00,000
Yearly equal installment, A = Rs. 1,50,000
n = 15 years
i= 20%

.
15

1,50,000 1,50,0001,50,000
6,00,000
AE (i%) = P(A/P,i%,n) + A
= 6,00,000 (A/P,20%,15) + 1,50,000
= 6,00,000 (0.2139) + 1,50,000
= Rs. 2,78,340.

1,50,000

A company invests in one of the two mutually exclusive alternatives.

The life of both alternatives is estimated to be 5 years
With the following investments , annual return and salvage value.
Alternative
A
(Rs.)

Alternative B
(Rs.)

Investment (Rs.)

-1,50,000

-1,75,000

Annual equal return

(Rs.)

60,000

70,000

Salvage value (Rs.)

15,000

35,000

Determine the best alternative based on the annual equivalent method by

assuming i = 25%, compounded annually.

Alternative A
Initial investment , P = Rs.1,50,000
Annual equal return, A = Rs. 60,000
Salvage value, S = Rs.15,000
Life n = 5 years
60,000 60,000 60,000

60,000 60,000 +15,0

P
AE (i%) = - P (A/P,i%,n) + A + S (A/F,i%,n)
= -1,50,000 (A/P,25%,5) + 60,000 + 15,000 (A/F,25%,5)
= -1,50,000 (0.3718) + 60,000 + 15,000 (0.1218)
= Rs. 6,507.

Alternative B
Initial investment , P = Rs.1,75,000
Annual equal return, A = Rs. 70,000
Salvage value, S = Rs.35,000
Life n = 5 years
70,000 70,000 70,000

70,000 70,000 +35,0

1,75,000
AE (i%) = - P (A/P,i%,n) + A + S (A/F,i%,n)
= -1,75,000 (A/P,25%,5) + 70,000 + 35,000 (A/F,25%,5)
= -1,75,000 (0.3718) + 70,000 + 35,000 (0.1218)
= Rs. 9,198.

RESULT :
The annual equivalent net return of alternative B is more than that of
alternative A. Thus the company should select alternative B.

RATE OF RETURN METHOD

The expenditure is always assigned with
negative sign.
The revenue/inflow are assigned with positive
sign.

RATE OF RETURN METHOD

(CASH FLOW DIAGRAM)
S

R
1
0

R
2
1

R
3
3

R
j

R
n

P
Here P initial investment.
Rj net revenue at the end of jth year.
S the salvage value at the end of nth year.
i the interest rate compounded annually.
PW(i) = -P + R1(1+i)1 + R2(1+i)2+. + Rj (1+i)j +..+ Rn(1+i)n +
n

A person is planning a new business.

The initial outlay and cash flow for the new business are listed below.
The expected life of the business is five years.
Find the rate of return for the new business.

Period

Cash
flow (Rs.)

30,000
1,00,00
0

30,0
00

30,000

30,000

30,000

Initial Investment , P = Rs. 1,00,000

Annual equal revenue, A = Rs.30,000
Life n = 5 years

30,000

30,000 30,000

1,00,000
The present worth of the business is
PW(i) = - P + A (P/A,i%,n)
= -1,00,000 + 30,000 (P/A,i%,5)

30,000

30,000

When i= 10%
PW(i%) = -1,00,000 + 30,000 (P/A,i%,5)
= - 1,00,000 + 30,000 (P/A,10%,5)
= - 1,00,000 + 30,000 (3.7908)
= Rs.13,724.
When i= 15%
PW(i%) = -1,00,000 + 30,000 (P/A,i%,5)
= - 1,00,000 + 30,000 (P/A,15%,5)
= - 1,00,000 + 30,000 (3.3522)
= Rs. 566.
When i= 18%
PW(i%) = -1,00,000 + 30,000 (P/A,i%,5)
= - 1,00,000 + 30,000 (P/A,18%,5)
= - 1,00,000 + 30,000 (3.1272)
= - Rs.6,184.

i = i% + PW(i%) positive O
------------------------------------- * (i%)
PW(i%) PW(i%) negative
= 15% +

566 O
------------------------------------- * (3%)
566 (- 6184)

= 15% + 0.252 %
= 15.252 %